Expansionary policy seeks to accelerate economic growth, while contractionary policy seeks to restrict it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.
This is done by increasing the money supply available in the economy. Expansionary policy attempts to promote aggregate demand growth. As you may remember, aggregate demand is the sum of private consumption, investment, government spending and imports. Monetary policy focuses on the first two elements. By increasing the amount of money in the economy, the central bank encourages private consumption. Increasing the money supply also decreases the interest rate, which encourages lending and investment.
The increase in consumption and investment leads to a higher aggregate demand. It is important for policymakers to make credible announcements. If private agents consumers and firms believe that policymakers are committed to growing the economy, the agents will anticipate future prices to be higher than they would be otherwise. The private agents will then adjust their long-term plans accordingly, such as by taking out loans to invest in their business.
A central bank can enact an expansionary monetary policy several ways. The primary means a central bank uses to implement an expansionary monetary policy is through open market operations.
Commonly, the central bank will purchase government bonds, which puts downward pressure on interest rates. The purchases not only increase the money supply, but also, through their effect on interest rates, promote investment. Because the banks and institutions that sold the central bank the debt have more cash, it is easier for them to make loans to its customers.
As a result, the interest rate for loans decrease. Businesses then, presumably, use the money it borrowed to expand its operations. This leads to an increase in jobs to build the new facilities and to staff the new positions.
The increase in the money supply is inflationary, though it is important to note that, in practice, different monetary policy tools have different effects on the level of inflation. Another way to enact an expansionary monetary policy is to increase the amount of discount window lending.
The discount window allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions. Decreasing the rate charged at the discount window, the discount rate, will not only encourage more discount window lending, but will put downward pressure on other interest rates.
Low interest rates encourage investment. Bank of England Interest Rates : The Bank of England the central bank in England undertook expansionary monetary policy and lowered interest rates, promoting investment. Another method of enacting a expansionary monetary policy is by decreasing the reserve requirement.
All banks are required to have a certain amount of cash on hand to cover withdrawals and other liquidity demands. By decreasing the reserve requirement, more money is made available to the economy at large. Monetary policy is can be classified as expansionary or restrictive also called contractionary.
Restrictive monetary policy expands the money supply more slowly than usual or even shrinks it, while and expansionary policy increases the money supply. Business cycle : Restrictive monetary policy is used during expansion and boom periods in the business cycle to prevent the overheating of the economy. Contractionary policy attempts to slow aggregate demand growth. By decreasing the amount of money in the economy, the central bank discourages private consumption. Decreasing the money supply also increases the interest rate, which discourages lending and investment.
The higher interest rate also promotes saving, which further discourages private consumption. The decrease in consumption and investment leads to a decrease in growth in aggregate demand. If private agents consumers and firms believe that policymakers are committed to limiting inflation through restrictive monetary policy, the agents will anticipate future prices to be lower than they would be otherwise.
The private agents will then adjust their long-term strategies accordingly, such as by putting plans to expand their operations on hold. A central bank can enact a contractionary monetary policy several ways. The central bank can issue debt in exchange for cash.
This results in less cash being in the economy. Because the banks and institutions that purchased the debt from the central bank have less cash, it is harder for them to make loans to its customers. As a result, the interest rate for loans increase.
Businesses then, presumably, have less money to use to expand its operations or even maintain its current levels. This could lead to an increase in unemployment.
The higher interest rates also can slow inflation. Consumption and investment are discouraged, and market actors will choose to save instead of circulating their money in the economy.
Effectively, the money supply is smaller, and there is reduced upward pressure on prices since demand for consumption goods and services has dropped. Another way to enact a contractionary monetary policy is to decrease the amount of discount window lending. Nonetheless, we can project the results from this static model to the dynamic world without much loss of relevance. In contrast, any decrease in the money supply or decrease in the growth rate of the money supply is referred to as contractionary monetary policy.
Suppose the money market is originally in equilibrium in Figure The ceteris paribus assumption means we assume that all other exogenous variables in the model remain fixed at their original levels. At the original interest rate, real money supply has risen to level 2 along the horizontal axis while real money demand remains at level 1. This means that money supply exceeds money demand, and the actual interest rate is higher than the equilibrium rate. The final equilibrium will occur at point B on the diagram.
Thus expansionary monetary policy i. In contrast, contractionary monetary policy a decrease in the money supply will cause an increase in average interest rates in an economy. Note this result represents the short-run effect of a money supply increase. The currency component of the money supply, using the M2 definition of money, is far smaller than the deposit component. Currency includes both Federal Reserve notes and coins. The Board of Governors places an order with the U.
Currently, the notes are no longer marked with the individual district seal. The Federal Reserve Banks typically hold the notes in their vaults until sold at face value to commercial banks, which pay private carriers to pick up the cash from their district Reserve Bank. When the demand for notes falls, the Reserve Banks accept a return flow of the notes from the commercial banks and credit their reserves.
The Board of Governors places orders with the appropriate mints. The system buys coin at its face value by crediting the U. The Federal Reserve System holds its coins in coin terminals, which armored carrier companies own and operate.
The commercial banks pay the full costs of shipping the coin. In a fractional reserve banking system, drains of currency from banks reduce their reserves, and unless the Federal Reserve provides adequate additional amounts of currency and reserves, a multiple contraction of deposits results, reducing the quantity of money. Currency and bank reserves added together equal the monetary base, sometimes known as high-powered money. The Federal Reserve has the power to control the issue of both components.
If the Federal Reserve determines the magnitude of the money supply, what makes the nominal value of money in existence equal to the amount people want to hold? A change in interest rates is one way to make that correspondence happen. A fall in interest rates increases the amount of money people wish to hold, while a rise in interest rates decreases that amount.
A change in prices is another way to make the money supply equal the amount demanded. When people hold more nominal dollars than they want, they spend them faster, causing prices to rise. These rising prices reduce the purchasing power of money until the amount people want equals the amount available. Conversely, when people hold less money than they want, they spend more slowly, causing prices to fall. As a result, the real value of money in existence just equals the amount people are willing to hold.
At first, the Federal Reserve controlled the volume of reserves and of borrowing by member banks mainly by changing the discount rate. It did so on the theory that borrowed reserves made member banks reluctant to extend loans because their desire to repay their own indebtedness to the Federal Reserve as soon as possible was supposed to inhibit their willingness to accommodate borrowers. In the s, when the Federal Reserve discovered that open-market operations also created reserves, changing nonborrowed reserves offered a more effective way to offset undesired changes in borrowing by member banks.
In the s, the Federal Reserve sought to control what are called free reserves, or excess reserves minus member bank borrowing. The Fed has interpreted a rise in interest rates as tighter monetary policy and a fall as easier monetary policy. But interest rates are an imperfect indicator of monetary policy. If easy monetary policy is expected to cause inflation, lenders demand a higher interest rate to compensate for this inflation, and borrowers are willing to pay a higher rate because inflation reduces the value of the dollars they repay.
Thus, an increase in expected inflation increases interest rates. Between and , for example, U. Similarly, if tight monetary policy is expected to reduce inflation, interest rates could fall. From to , when Paul Volcker was chairman of the Federal Reserve, the Fed tried to control nonborrowed reserves to achieve its monetary target. The procedure produced large swings in both money growth and interest rates.
Forcing nonborrowed reserves to decline when above target led borrowed reserves to rise because the Federal Reserve allowed banks access to the discount window when they sought this alternative source of reserves. Since then, the Federal Reserve has specified a narrow range for the federal funds rate, the interest rate on overnight loans from one bank to another, as the instrument to achieve its objectives.
Although the Fed does not directly transact in the Fed funds market, when the Federal Reserve specifies a higher Fed funds rate, it makes this higher rate stick by reducing the reserves it provides the entire financial system.
When it specifies a lower Fed funds rate, it makes this stick by providing increased reserves. The Fed funds market rate deviates minimally from the target rate. If the deviation is greater, that is a signal to the Fed that the reserves it has provided are not consistent with the funds rate it has announced.
It will increase or reduce the reserves depending on the deviation.
0コメント